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Chapter 23.docx

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Brock University
Marilyn Cottrell

Chapter 23: Output and Prices in the Short Run Introduction: Shocks and Price changes: 1. Exogenous changes in price level- demand side changes 2. Supply side changes- factor prices 3. Macro Equilibrium- demand, supply and price level The Demand Side of the Economy: Shifts in the AE Curve 1. Exogenous change in price level, P  Increase in P reduces the real value of money [in private sector]  Fall in P raises the real value of money holdings  Change in P affect wealth of bondholders and bond issuers [offset each other- no change in aggregate wealth] Changes in wealth affect Consumption [C]: Increase in P reduces private-sector wealth  Decreases desired Consumption  AE curve shifts down Fall in P increases private-sector wealth  Increases desired Consumption  AE curve shifts up Price changes affect Net Exports [NX]: Prices rise in Canada- foreign prices are constant Canada’s Export fall Imports rise  Shifts the NX function leftward  AE curve falls  Conversely for a fall in Canada’s Prices Changes in Equilibrium GDP Prices increase, AE function shifts downward An increase in P  Reduces private-sector wealth  Reduces desired AE  AE curve shifts down  Reduces equilibrium level of real GDP (Y) The Aggregate Demand Curve: Aggregate Demand (AD) Curve  Relates equilibrium real GDP to the price level For any given price level  AD curve shows level of real GDP where desired aggregate expenditure equals actual GDP Changes in price level  Causes shifts in AE curve  Cause movements along AD curve Increase in P  Shifts AE down  Equilibrium GDP falls Decrease in P  Shifts AE up  Equilibrium GDP rises Changes in P shown by movements along Aggregate Demand curve Decline in P  Increase quantity demanded When price is lower, buy more only applies to one good With substitutes  Apples cheaper, so buy more apple and fewer bananas] One case of substitutes: If domestic prices fall  Buy more domestic goods  Buy fewer imports Main reason:  Real wealth increases when P falls [Real Balances] AD increases [shifts]: At a given price level:  Any position shock [increase in Exports (X)]  Increases equilibrium GDP  Increases AD- shifts AD rightward  Any negative shock [fall in Investment (I)]  Decreases equilibrium Y  Decreases AD- shifts the AD leftward  K x change in A measures size of horizontal shift of AD curve Exports rise  Price level constant  AE shifts up  AD shifts rightward  An increase in AD  Change in AD = K x Change in A Summary 1. Price level changes a) AE line shifts up or down (C changes (real balances effect)and NX change) b) Move up or down AE curve e.g. price level rises – a) AE shifts down (X and NX fall) b) Move left and up AD curve. 2. Autonomous expenditures (I, G, X) changes: a) AE line shifts up or down b) AD curve shifts right or left e.g. I increases – a) AE shifts up b) AD shifts right. More is demand at the same price level. The Supply Side of the Economy The Aggregate Supply Curve: Short-run aggregate supply (AS) curve  Rel
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